The Effects Of Remittances On Economic Growth: Reexamining The Role Of Institutions

The extant literature is unclear about the effects of remittances on economic growth and the role of governance institutions. This study contributes to knowledge by investigating how domestic institutional capacity determines the ability of developing countries to benefit from remittance inflows. We employ data for 106 developing countries over a 13-year period (1996 to 2013) to test two related hypotheses. First, we test the hypothesis that countries with weak institutions will 'import' growth in the form of international remittances, to make up for any loss in growth arising from the 'bad' institutions. We call this the growth importation hypothesis. Second, we test the hypothesis that the synergetic growth value of the interaction between weak institutions and remittances will be positive due to the fact that the urgency to apply remittances efficiently in countries with weak institutions is high because of limited alternatives (that is, the opportunity cost of misapplying remittance proceeds is high). We call this the urgency hypothesis. We find strong evidence of the existence of both hypotheses. Specifically, we find that remittances stimulate economic growth in the full sample and in low income and lower middle income countries, but do not foster growth in upper-middle and high-income countries. On their own, domestic institutions in low income and lower middle-income countries do not promote growth unless they are combined with remittances. However, in upper middle and high-income countries, institutions, on their own, are strong enough to promote growth, and, in doing so, act as substitutes to remittances in economic growth. It is clear from the positive effect of institutions, physical capital and inflation on growth in upper-middle-income and high-income countries that, the strengthening of institutions, the rapid accumulation and effective utilization of physical capital, and the pursuit of macroeconomic stability are vital for promoting growth in these countries. For low income and lower middle-income countries, they must upgrade their institutions to reduce market imperfections, and ensure investments in growth enhancing projects. But until then, low income and lower middle-income countries must facilitate remittance inflows in order to spur growth.